Wednesday, August 19, 2015

The back door to a Roth

For 2015, the combined contributions to all of your traditional and Roth IRAs cannot be more than $5,500 ($6,500 if age 50 or over) or the amount of your taxable earned income, whichever is less. Your contribution to a traditional IRA account is deductible subject to certain income limitations. If you are not covered by a retirement plan and your filing status is single, then there is no income limitation. If you are filing as married filing jointly, and your spouse is also not covered by a retirement plan at work, then there is no income limitation. If your spouse is covered, then your contribution is deductible if your Modified Adjusted Gross Income (MAGI) is less than $183,000, and your deduction is phased out between $183,000 and $193,000. If you are covered by a retirement plan at work and your filing status is single, you can deduct the full amount of your IRA contribution if your MAGI is under $61,000. Your deduction is phased out between $61,000 and $71,000. If you are covered by a retirement plan at work and your filing status is married filing jointly, then you can deduct up to the amount of your contribution limit if your MAGI is under $98,000 and your deduction is phased out between $98,000 and $118,000.
The $5,500 ($6,500 if age 50 or over) limits also apply to Roth IRA contributions. However, your Roth contribution might also be limited by your filing status and income. If your filing status is single, then your Roth contribution limit is phased out between $116,000 and $131,000. If you are filing as married filing jointly, your contribution limit is phased out between $183,000 and $193,000. Roth IRAs are desirable because the money will grow tax-deferred and can be withdrawn tax-free subject to withdrawal rules.
The “back door” Roth  is a way for taxpayers with incomes above the phase-out limits to make an annual contribution to a Roth IRA. If you are above the income limits you can contribute to your traditional IRA and then convert that contribution to a Roth by rolling it over to a Roth IRA. Despite what you might read elsewhere, the conversion may not be tax-free. If you have any pre-tax money in a traditional IRA account, then you must prorate the conversion amount by the ratio of taxable versus nontaxable money in all of your traditional IRA accounts to determine the taxable amount of the conversion. Taxpayers who want to employ this strategy should talk to their tax practitioner and follow IRS Roth conversion rules.